Wal-Mart Stores (NYSE:WMT) has a problem, and Credit Suisse analyst Michael Exstein thinks he has the solution. Buy Family Dollar Stores (UNKNOWN:FDO.DL). Wal-Mart has been struggling to show growth in recent times partly due to smaller stores capturing what it describes as "fill-in" quick trips during the week. Exstein outlines a compelling case for the acquisition, and here are five additional clues.
The Exstein thoughts
Exstein points out that Wal-Mart has been successfully growing abroad via acquisitions. Why not then, Exstein reasons, shouldn't the company use that same strategy domestically and acquire a retail chain here, specifically Family Dollar Stores?
Wal-Mart plans to open 150 or so small-format stores with a target of 700 of them by the year 2017 as its current domestic strategy. It's a "drop in the bucket" compared to the more than 23,000 stores of the three dollar chains, as Exstein puts it. And he has a point. That's only 3% as many.
Family Dollar, according to Exstein's calculation, gives Wal-Mart an advantage of geography. Nearly half of Wal-Mart stores are within one mile of a Dollar Tree Stores (NASDAQ:DLTR) location, and 29% of them are within one mile of a Dollar General (NYSE:DG). However, just 19% of them are near a Family Dollar. This makes Family Dollar the preferred choice, as it would allow Wal-Mart to have greater reach and potentially more market share.
Five more reasons
First, Wal-Mart's greatest assets are its brand, image, and reputation. Not that there is anything wrong with the names Dollar Tree or Dollar General, but Family Dollar does fit in with that theme.
Second, the factors that have made Wal-Mart so profitable are the sheer volume of "stuff" it buys and the average per-unit discount that results. As such, any cross products between stores would add to its already enormous volume of goods and lead to cheaper costs for the company, probably cheaper than Family Dollar is currently paying.
Third, Wal-Mart sells a number of private-label brands such as Sam's Choice and Equate in its stores. These are often more cheaper alternatives of popular brand name products. Consumers love them because it allows them to save money. Wal-Mart loves them because they have higher profit margins for the company than the resale of the brand name equivalents. If Wal-Mart were to purchase Family Dollar, it would have a new venue to sell these private label brands in. Since private label brands are cheaper for Wal-Mart to stock, it may also open up the door to completely new product categories that Family Dollar currently can't afford to supply..
Fourth, the Wal-Mart credit card. A Wal-Mart-owned Family Dollar could mean that the dollar chain can start accepting this store card, and more people may apply for it in the first place if they are already regulars of Family Dollar.
Fifth, many people might not know this, but Family Dollar is not a 100% true dollar store. Only around 90% of its products are actually at the $1 price point. This gives Wal-Mart the flexibility to add additional popular products of its own priced higher than $1 that would fit in well with the store. Wal-Mart wouldn't as easily have that flexibility with Dollar Tree.
But what's in it for Family Dollar?
Family Dollar Stores has been growing overall on a percentage basis, which Wal-Mart craves, but it could use some corporate retail-giant muscle against rivals Dollar Tree and Dollar General. Analysts expect the chain to grow sales by 2% this year and 7% next, which isn't bad, but it trails Dollar Tree and Dollar General.
Last quarter Dollar Tree saw sales jump 9.5%, while Dollar General saw a rise of 10.5%. While Dollar Tree is expected to further grow by 7% this year and 9% next year, Dollar General should do even better with estimates at 10.1% and 9.6%, respectively. Perhaps a Wal-Mart love tap can make Family Dollar the leader of the trio.
Foolish final thoughts
It will be interesting to see what, if anything, will develop. By Exstein making his thoughts public, he may have planted a seed in Wal-Mart's proverbial brain -- or its competitors. We may even see Target or somebody else take a stab at a Family Dollar acquisition or even an acquisition of Dollar Tree or Dollar General. If that happens with one of them, look for others to follow.
Either way, Fools should take a close look at Family Dollar, Dollar Tree, and Dollar General. The potential acquisition wild card is a nice bonus and could help expand each stock's P/E multiple.
Nickey Friedman has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.